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Share buybacks are in the news. And there are not one but two reasons for this. Obviously, one is that Reliance Industries has announced one which, if it lives up to the hype, could be the largest ever in India at about . 15,000 crore. The other reason could actually be more important. The Securities and Exchange Board of India (Sebi) is said to be in the process of changing the rules of buybacks in order to give an advantage to small investors.
However, Reliance's buyback will have nothing to do with the change in regulations. The thing to understand here is that there are two entirely different ways in which companies can buy back there shares.
In one method, companies make an offer to all shareholders to buy back a proportion of the shares they own. So if the company is planning to buy back 1% of its shares, than all shareholders get a fair chance to sell back 1 share for every 100 they own. It's rather like a rights issue in reverse. You have the right to sell a certain number of shares at an offered price, which you may choose to exercise or not. What Sebi is doing now is to give smaller shareholders an enhanced right to participate in buybacks. Under the new rules, the buyback ratio will be higher for those shareholders who hold less than a certain number of shares. Since buybacks are always done at a price that is higher than the prevailing market price, this gives smaller shareholders a bit of a leg up. Financially, all shareholders are still treated equal because the smaller ones still get the same price as others — they are just able to sell a higher proportion if they want to. Sebi is doing this because it believes that larger and institutional shareholders have inherent advantages and this restores the balance a little bit.
However, this is not all there is to buybacks. There is another route which is not a very structured one. In this, a company just announces that it will conduct a buyback and states the total amount and a maximum price. It could say, for example, that it will buy up to . 1,000 crore of shares at a maximum price of . 500 a share over a certain period of time. This announcement is just a nonbinding statement of intent. The amount and the price is a maximum. It is under no obligation to actually buy anything close to the amount it has announced. The actual purchases are made on the exchanges through stock brokers and the company just announces periodically how much buyback has been done and how much of its capital has thus been extinguished.
Of course, when a company announces a buyback, it is very likely to get a bump up in its stock price based on the maximum size of the buyback offer it has announced, something which is of obvious advantage to a lot of people. So in this sense, if the buyback is less (or, as it frequently happens, a lot less) than the original announcement, then that announcement eventually amounts to not much more than a misleading statement that moves the price at some point of time. There have been many cases like this in the past and as it happens, Reliance's own previous buyback announcement was something like this. In December 2004 the company announced that it would buy back close to . 3,000 crore worth of shares. The price ran up by more than 10% in a fortnight but the buyback was eventually just a meagre 5% of the announced amount. Of course, that was at the height of the brothers' conflict. The then vice-chairman Anil Ambani had made strong public statements against the buyback plan and that may have had something to do with its fate.
However, the moral of the story probably is that this laissez faire route of asyou-like optional buybacks should be abandoned. They can easily amount to price manipulation and they are not in the shareholder's best interest, which are best served by buybacks through the other route.
Companies should make a public commitment to the shareholders on buyback and then be obligated to stick to it.
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